This blog is a commentary on contemporary business, politics, economics, society, and culture, based on the values of Reason, Rational Self-Interest, and Laissez-Faire Capitalism. Its intellectual foundations are Ayn Rand's philosophy of Objectivism and the theory of the Austrian and British Classical schools of economics as expressed in the writings of Mises, Böhm-Bawerk, Menger, Ricardo, Smith, James and John Stuart Mill, Bastiat, and Hazlitt, and in my own writings.

Over the
course of several generations, the US government has taxed away trillions upon
trillions of dollars that otherwise would have been saved and invested and
thereby added to the capital of the American economy. Capital is the wealth
owned by business firms, which is used for the purpose of earning sales
revenues and profits. It consists of farms, mines, factories, machines, tools,
materials, components, semi-manufactures, means of transportation, warehouses,
stores, merchandize of all kinds, and more. It includes the funds used to pay wages
to the employees of business firms, and the funds used to finance the purchase
of expensive consumers’ goods, such as houses, automobiles, and major
appliances. The trillions have been taken away through the progressive personal
income tax, the corporate income tax, the estate tax, the capital gains tax,
and the social security system and its taxes. In addition, the US government
has diverted trillions of dollars of savings away from investment, and into its
coffers, in order to finance its chronic budget deficits. And its policies of
chronic inflation and credit expansion have caused the waste of a substantial
portion of the greatly reduced supply of capital that remains.

Inflation
and the continuing rise in home prices that it fuels, led to owner-occupied
housing, a consumers’ good as much as one’s personal automobile or furniture,
coming to be thought of as a capital good and thus a vehicle for investment,
thereby diverting substantial sums away from actual investment and into home
purchases. Massive credit expansion pouring into the real estate market
resulted in the last decade in millions of homes being constructed for buyers
who could not afford to pay for them, thus representing a massive unremunerated
transfer of wealth and causing a corresponding deficiency in the capital of
producers throughout the economic system. And inflation has led to artificially
increased profits and correspondingly increased taxes on those profits, despite
the fact that the additional profits are needed merely to meet the rise in
replacement costs that results from inflation and thus are not at all any kind
of genuine gains.

The massive
loss of capital resulting from all this, is reflected not only in the recent
recession/depression, but in the much larger-scale wiping out of much of the
industrial base of the United States and its replacement with the “rustbelt.”
As a consequence of this devastation, the populations of once great American
cities, such as Detroit, St. Louis, Cleveland, and Pittsburgh have been
decimated. Much of Detroit is now on the verge of reverting to farmland.

True,
competition from abroad coupled with major impediments to competition at home,
most notably government-sanctioned coercive labor unions, played a substantial role.
But such devastation would not have occurred if the trillions of dollars seized
or otherwise absorbed by the US government over the years at the expense of
saving and investment, and the additional trillions wasted as the result of
government policies, had instead been available to the American economy as
capital.

The
deficiency of capital has been compounded by a steadily growing list of
government imposed rules and regulations written and enforced by dozens of
government agencies and now amounting to more than 700,000 pages. (Among them,
of course, are those that compel dealing with labor unions.) These rules and
regulations exist for the purpose of forcing business firms to do what is
unprofitable or prevent them from doing what is profitable. In both cases, the
effect is higher costs of production than are necessary, inasmuch as having to
do what is unprofitable typically means having to incur unnecessary additional
costs, while being prevented from doing what is profitable frequently means
being prevented from doing what is less costly.

Higher
costs of production in turn mean less efficiency in production and thus less
output coming from the same capital. The reduced output means not only a
reduced output of consumers’ goods but also a reduced output of capital goods.
(Capital goods, no less than consumers’ goods, are a regular product of the
economic system and their supply is affected by whatever affects production in
general.[1]) Thus, there is the compound
problem of less capital producing fewer capital goods per unit. This is a
twofold reduction in the supply of capital goods and one that is ongoing, as
fewer capital goods in a period result in correspondingly fewer capital goods
in the next period, as well as fewer consumers’ goods.

The
government’s massive assault on the supply of capital has begun to transform
the American economic system from one of continuous economic progress and
generally rising living standards into one of stagnation and outright decline.
People are shocked and outraged as they see the standard of living fall. They
had believed that while physical nature might be fragile and damaged by the
loss even of a single species of plant or animal life, the economic system was
indestructible. No tax, no regulation, was ever too much for it. The cost would
always somehow come out of the profits of the rich, not the standard of living
of the average wage earner, even if the ever-repeated additional costs came
quickly to exceed all the profits of the economic system.

As people
have learned that the economic system is not indestructible, they have turned
in anger and resentment against “economic inequality,” as though it were the
surviving wealth of others that was the cause of their poverty, rather than the
fact that, thanks to the government, others do not have sufficient capital to
supply and employ them in the manner they would like.

Now into
the midst both of the assault on the capital supply of the American economic
system and its ability to produce, and the unfounded resentment against
economic inequality that has been stirred up by the impoverishment caused by
that assault, has stepped one Thomas Piketty. Piketty, a neo-Marxist French
Professor has written a near-700-page book published by Harvard University
Press. His book is titled Capital in the
Twenty-First Century, in honor of Karl Marx’s 19th century Das Capital. It has been greeted with
fervent applause from the left-wing intellectual establishment, including reviews
in The New York Times, Newsweek, Time
Magazine, The Daily Beast, The Huffington Post, and elsewhere ranging from
highly favorable to glowing. His book has been on the best-seller lists of both
The Times and Amazon.com.

Piketty
urges measures purposefully designed to further prevent the accumulation of
capital, indeed, to achieve outright capital decumulation. Namely, a
progressive income tax as high as 80 percent “on incomes over $500,000 or $1
million a year,” accompanied by a progressive tax directly on capital itself,
as high as 10 percent per year. This program is to be carried out in order “to
avoid an endless inegalitarian spiral.”[2]

While
ostensibly a book devoted to the study of capital and its rate of return,
Piketty comes to his subject apparently without having read a single page of
Ludwig von Mises or Eugen von Böhm-Bawerk, the two leading theorists of capital
and its rate of return. There is not a single reference to either of these men
in his book. There are, however, seventy references to Karl Marx. And while
Piketty displays familiarity with some aspects of the ideas of David Ricardo,
he shows no knowledge whatever of Ricardo’s major contribution to the theory of
capital accumulation, which contribution all by itself cuts the ground from
under his views on the subject.[3]

As a
result, Piketty advocates his program on the basis of ignorance of the
essential role of capital in production, which is to raise the productivity of
labor, real wages, and the general standard of living. He also never learned
that the freedom to accumulate great fortunes is necessary to the development
of new products and new industries, which is essential to economic progress.
Think what the effect would have been on the development of the automobile
industry if Henry Ford had been subject to an 80 percent income tax and a 10
percent capital tax, and on the petroleum industry if Rockefeller had been
prevented from accumulating the capital needed to build the oil refineries and
oil pipelines that he built, and on the development of any major new industry.
Their development would have been aborted for lack of capital.

The depths
of Piketty’s ignorance are such that he believes that capital accumulation not
only does not raise real wages but reduces
them, by allegedly increasing the share of national income that goes to profits
and correspondingly reducing the share that goes to wages, while the overall
total of what is produced remains unchanged or increases only very modestly,
and then not by virtue of any contribution to production made by capital.[4] This alleged result, of capitalists
growing richer at the expense of workers growing poorer, is what his
destructive program of confiscatory taxation is designed to prevent. His
doctrine is comparable to that of an alleged nutritionist claiming to have
discovered that eating is responsible for weight loss and that government must
make people eat less in order to avoid their becoming too thin. Or to that of
an alleged doctor claiming to have discovered that medicines are the source of
disease and that to promote health, they must be banned. As I will show, the
truth is that capital accumulation not only serves progressively to raise real
wages and the general standard of living, but also operates to increase the proportion
of national income in the form of wages and decrease the proportion in the form
of profits.

Piketty’s
ignorance concerning capital is compounded by his ignorance and confusions on
the subject of profit and the rate of profit. He believes, for example, that
technological progress raises the rate of profit, when in fact it has no
causative connection to the rate of profit but rather to the supply of goods,
including, most importantly, the supply of capital goods, which it increases
and whose prices it serves to decrease. Piketty confuses the increasing supply and
falling prices of capital goods caused by technological progress, with a
falling rate of profit. This is while simultaneously claiming, in full
contradiction, that technological progress raises the rate of profit.[5] As a result of such confusions, he
has no understanding of what actually determines the amount and rate of profit
in the economic system, matters which I will explain below.

Piketty’s ignorance
on the subjects of capital and profit is further compounded by his ignorance concerning
the subject of saving, both gross saving (i.e., saving out of business sales
revenues) and net saving (i.e., saving out of profits and wages). He makes no
distinction between net saving which occurs in the absence of increases in the
quantity of money and volume of spending in the economic system, and net saving
which occurs in the presence of increases in the quantity of money and volume
of spending in the economic system. Hence, he is not in a position to realize
that net saving in the former case necessarily comes to an end, with capital
accumulation and economic progress thereafter proceeding simply on the basis of
increasing production accompanied by falling prices, falling prices both of
capital goods and consumers’ goods. Nor is he able to realize that in the latter
case, while net saving is perpetuated, it is so only by a factor that
simultaneously operates to raise money incomes throughout the economic system,
thereby still preventing any possibility of accumulated savings and capital potentially
growing without limit relative to current money income, which claim is at the
core of his doctrine.[6]

And, of
course, his ignorance on the subject of capital prevents him from realizing
that capital accumulation, whether achieved through the same total sum of
capital in terms of money being accompanied by progressively falling prices of
capital goods, or through increasing supplies of capital goods being
accompanied by a growing sum of capital in terms of money, is what underlies
economic progress and rising real wages and general standard of living.

As stated, Piketty
simply does not see additional capital as being necessary for an increase in
production and rise in living standards. He believes that it is somehow merely
a means of creating growing economic inequality and an actual decrease in the
living standards of wage earners, and thus that its increase needs to be
forcibly restrained. He dismisses any need for additional capital accumulation
when he writes of “structural growth” and “productivity growth” that are
allegedly not tied to capital accumulation.

He
declares:

Recall that g [growth] measures the
long-term structural growth rate, which is the sum of productivity growth and
population growth. In Marx’s mind, as in the minds of all nineteenth - and
early twentieth-century economists before Robert Solow did his work on growth
in the 1950s, the very idea of structural growth, driven by permanent and
durable growth of productivity, was not clearly identified or formulated. In
those days, the implicit hypothesis was that growth of production, and
especially of manufacturing output, was explained mainly by the accumulation of
industrial capital. In other words, output increased solely because every
worker was backed by more machinery and equipment and not because productivity
as such (for a given quantity of labor and capital) increased. Today we know
that long-term structural growth is possible only because of productivity
growth. But this was not obvious in Marx’s time, owing to lack of historical
perspective and good data.[7]

Piketty,
and Solow before him, recognize only one dimension of the supply of capital,
namely, the ratio of the monetary value of capital to national income, which
ratio Piketty calls the capital/income ratio. If that ratio does not rise,
there allegedly is no capital accumulation. (As expressed in that ratio, the
capital of the economic system is equal to the sum of every firm’s cash
holding, plus the purchase value of its inventory and work in progress, plus
the purchase value of its plant and equipment less accumulated annual
depreciation charges. National income is the sum of profits, inclusive of
interest charges, and wages and salaries, or profits plus wages, for short.)

They
observe that economic progress, i.e., a growing supply of goods and services
per capita, does not depend on a continuing rise in this ratio. It can continue
with an unchanged ratio of capital to income. Solow attributed this simply to technological
progress, as distinct from capital accumulation. Piketty attributes it to an
unexplained “productivity growth,” by which, I will assume, he nevertheless
means technological progress. (If this is not what he means, then his theory of
growth has no foundation whatever.) It is on this basis that Piketty, along
with Solow, dismisses capital accumulation as the cause of economic progress.

Neither of
them realizes that there is a second dimension to the increase in the supply of
capital, namely, increases in the supply of capital goods that take place
without an increase in the capital/income ratio.[8] They fail to realize not only that
capital accumulation can take place in the face of an unchanged capital/income
ratio but also that the height of this ratio is important to the rate of such
capital accumulation, and that capital accumulation is essential to the
implementation of technological advances.

Indeed, having
thus mistakenly disconnected economic progress from capital accumulation, Piketty
goes so far as to imagine the possibility of rapid productivity growth in the
complete absence of the use of capital. He writes:

As noted, it
is perfectly possible to imagine a society in which capital has no uses (other than to serve as a pure store of value,
with a return strictly equal to zero), but in which people would choose to hold
a lot of it, in anticipation, say, of some future catastrophe or grand potlatch
or simply because they are particularly patient and take a generous attitude
toward future generations. If, moreover,
productivity growth in this society is rapid, either because of constant
innovation or because the country is rapidly catching up with more
technologically advanced countries, then the growth rate may very well be
distinctly higher than the rate of return on capital.[9]

Here
Piketty states his belief that it is possible to have rapid productivity growth
and the adoption of the technologies of more advanced countries not only
without the use of additional capital, but without the use of any capital whatsoever.

For Piketty, “capital” is a word without
content—an empty symbol to be manipulated. He does not see that it embraces all
the goods that are ready for people to buy, along with the stores and
warehouses that hold those goods, along with the factories, farms, and mines,
and everything else in between, that is the source of those goods.He does not grasp that capital is the foundation
of the supply of goods that people buy and of the demand for the labor that
people sell. Only because he has no serious concept of capital, can he imagine
that it might have “no uses” and that its increase is harmful rather than
essential.

While the
theory of economic progress offered by Piketty is the assertion that economic
progress is the result either of totally unexplained “productivity growth” or
productivity growth based on technological progress divorced from capital
accumulation, the truth is that a rise in the productivity of labor and
concomitant economic progress almost always requires an increase in the supply
of physical capital goods relative to the supply of labor. For example, a
larger supply of iron ore per steel worker is essential for steel workers being
able to produce more steel per worker, as is a larger, better supply of capital
goods in the form of the plant and equipment used by the steel workers. The
same, of course, is true of the appropriate supplies of capital goods in every
branch of production.

It must be
stressed that capital goods are a regular product of the economic system, just
as much as consumers’ goods, and are used in the production of capital goods no
less than in the production of consumers’ goods. With this in mind, it becomes
clear that a one-time increase in the supply of capital goods achieved by
saving and an accompanying rise in the ratio of capital to income, can serve to
make possible a further increase in the supply of capital goods, and that this
process can be repeated indefinitely. This is because capital goods are employed
reproductively. That is, for example, steel mills, power plants, and oil
refineries contribute to the production of steel mills, power plants, and oil
refineries along with all the other goods in whose production they directly or
indirectly serve. Indeed, if the economic system is not to go into decline, the
existing supply of capital goods must be used to produce capital goods at least
sufficient to replace the capital goods used up in production.

For
continuing capital accumulation to take place on the foundation of a one-time
rise in saving and the capital/income ratio, all that is required is two
things. First, that a sufficient proportion of production be devoted to the
production of capital goods, i.e., a proportion greater than the proportion required
merely to replace the capital goods being consumed in production. Whether or
not such a proportion is achieved and maintained depends on the demand for
capital goods relative to the demand for consumers’ goods in the economic
system, which in turn depends on the degree of gross saving relative to
consumption expenditure in the economic system.

Second,
that the diminishing returns accompanying the application of successive
increments of capital goods in conjunction with the same quantities of labor be
offset by technological progress. What this means, for example, is that from
time to time such things as the increasing quantities of iron and steel
available per worker be accompanied by steam shovels made of iron and steel
replacing conventional shovels made of iron and steel. While equipping a worker
with 1,000 or 10,000 conventional shovels would not increase his output beyond
what he can produce using just a single shovel, the same quantity of iron and
steel as is in that many shovels being instead in the form of a steam shovel,
can very dramatically increase his output.Such technological progress is essential to the continuing increase in
the supply of capital goods.

Thus, the
role of technological progress in raising the standard of living is not at all
something separate and distinct from capital accumulation. The truth is that
technological progress is an essential requirement of any large-scale capital
accumulation. For example, absent the technological progress of the last two
centuries, the supply of capital goods today could not radically exceed the
supply of capital goods present in the early 19th century, no matter
how great the degree of saving and how high the ratio of capital to income. In
the absence of technological progress, the maximum possible savings of that
time might have made possible some more or less considerable improvements in
sailing vessels, wagons, canals, and the like but not the production of
steamships, railroads, and motor vehicles, let alone power plants, electricity,
and all the capital goods that depend on electricity. All of these forms of
additional supplies of capital goods depended on the existence of technological
progress.

Technological
progress is what makes it possible for capital accumulation and its resulting
rise in the general standard of living to continue indefinitely, at an
undiminished rate. Technological progress is what maintains the productivity of
growing supplies of capital goods. In maintaining that productivity in the
production of capital goods themselves, it contributes to capital accumulation
and, through capital accumulation, to economic progress. Thus, it is not at all
the case, as Solow and Piketty believe, that technological progress is a
replacement or substitute for capital accumulation. To the contrary, it makes
its contribution as an essential element
in the process of capital accumulation.

While it is
clear that a continuing rise in the ratio of capital to national income is not
necessary to achieve economic progress, the height of the ratio is a matter of
great importance. Other things being equal, the higher is the ratio, the more
capable is the economic system of taking advantage of technological progress.

Technological
advances differ widely in their cost of adoption. The collection of
technological advances that were necessary for constructing a tunnel under the
English Channel rank among the most expensive to adopt. Those embodied in what
is required to open a modest-sized restaurant rank among the least expensive to
adopt. The higher is the capital/income ratio in a country, the more abundant
is its available supply of accumulated savings. And thus the more likely will
it be in a position to afford to implement costly technological advances and
thus to achieve the benefits they can provide to the further production of
capital goods. Consequently, the higher the capital/income ratio, the more
rapid is the rate of economic progress.

Relating
this back to the discussion, at the beginning of this essay, of the
government’s draining of funds from the economic system that would otherwise
have been saved and invested, it is now possible to understand the effect in
terms of our now having a far lower capital/income ratio and thus rate of
economic progress than we otherwise would have had. The effect has been to
diminish our ability to adopt technological advances that are relatively more
costly and thus require larger sums of capital to implement. This lack of
capital has deprived us not only of the adoption those advances but also of the
additional supplies of capital goods that would have resulted from their
adoption.

The
relationship between technological progress and capital accumulation is
reciprocal. On the one hand, technological progress, by virtue of offsetting
diminishing returns to additional supplies of capital goods, is necessary to continuing
capital accumulation without any progressive rise in the ratio of capital to
income. At the same time, capital accumulation is necessary to the ability to
adopt technological advances. The necessity of capital accumulation to the
adoption of technological advances is not only that of a higher ratio of
capital to national income, but also, and much more often, that simply of a
larger supply of capital goods that does not reflect a higher such ratio but
merely a sufficient accumulation of capital on the foundation of previous
adoptions of technological advances. For example, the United States could adopt
the technological advances that constituted the electronics industry, because
it had the pre-existing foundation of an electrical industry, a chemical
industry, and the various metals industries, to name a few. It could certainly
not have adopted such advances a century earlier, on the foundation of the then
much smaller supply of capital goods.

As Mises
observed in his seminar, almost all of the technological advances of the last
centuries are available to and can be fully understood by engineers in even the
most impoverished corners of the world. What stops the implementation of those
advances is not any lack of technological knowledge but a lack of capital.
Thus, a farmer in India who has seen a tractor on television can easily
understand the value of using one. What stops him from using one is certainly
not any lack of technological knowledge. It is certainly not that he does not
know how to operate a tractor or could not easily be taught how to do so. What
stops him is that he cannot afford a
tractor. He does not possess the capital necessary to buy a tractor and cannot
find a lender to provide it. This is a lack of capital that probably could not be
made good by any rise in the local capital/income ratio. It reflects
generations of insufficient local capital accumulation.[10]

Piketty’s
ignorance concerning the role of capital accumulation in economic progress is
closely related to the prevailing widespread ignorance concerning the
determinants of the rate of profit, which he fully shares. Most contemporary
economists mistakenly believe that technological progress, in raising the
physical productivity of capital goods, operates to raise the rate of profit on
capital, while increases in the supply of capital goods operate to reduce the
rate of profit.

Piketty
writes:

According
to the simplest economic models…the rate of return on capital should be exactly
equal to the “marginal productivity” of capital (that is, the additional output
due to one additional unit of capital).…In any case, the rate of return on
capital is determined by the following two forces: first, technology (what is
capital used for?), and second, the abundance of the capital stock (too much
capital kills the return on capital).[11]

The supporters
of the marginal productivity of capital doctrine need to explain how the few
dollars of additional profit that might be earned somewhere by virtue of the
investment of an additional $100 translates into trillions of dollars of profit
in the economic system.

As shown, the
actual role of technological progress is to maintain the ability of additional
supplies of capital goods to increase production, including the ability to
produce further capital goods. The rate of profit is not determined either by
technological progress or by the supply of capital goods. A growing supply of
capital goods causes lower prices of capital goods, not a lower rate of profit.
Technological progress causes a growing supply of goods, including capital
goods, and thus more lower prices. It does not cause a higher rate of profit,
nor does it cause a lower rate of profit (viz., by virtue of increasing the
supply of capital goods.)

As I will
show, the rate of profit is determined by broad factors operating across the
economic system, namely, by “net consumption” and net investment, which latter
reflects the rate of increase in the quantity of money and volume of spending
in the economic system, while the former reflects the prevailing degree of time
preference.[12]

As
indicated, Piketty believes that an increase in the capital/income ratio not
only does not contribute to economic progress and rising living standards but
is actually harmful. In his eyes, it
serves merely to increase economic inequality and the share of national income
going to capitalists, while reducing the share going to wage earners.

The
underlying problem, according to Piketty, is the excess of the rate of return
(profit) over the rate of growth. He writes:

If, moreover, the rate of return on
capital remains significantly above the growth rate for an extended period of
time (which is more likely when the growth rate is low, though not automatic),
then the risk of divergence in the distribution of wealth is very high. This
fundamental inequality, which I will write as r > g (where r stands for the
average annual rate of return on capital, including profits, dividends, interest,
rents, and other income from capital, expressed as a percentage of its total
value, and g stands for the rate of growth of the economy, that is, the annual
increase in income or output), will play a crucial role in this book. In a
sense, it sums up the overall logic of my conclusions.[13]

He later
elaborates:

Let me now turn to the consequences
of r > g for the dynamics of the wealth distribution. The fact that the
return on capital is distinctly and persistently greater than the growth rate
is a powerful force for a more unequal distribution of wealth. For example, if
g = 1 percent and r = 5 percent, wealthy individuals have to reinvest only [a
little more than—GR] one-fifth of their annual capital income to ensure that
their capital will grow faster than average income. Under these conditions, the
only forces that can avoid an indefinite inegalitarian spiral and stabilize
inequality of wealth at a finite level are the following. First, if the
fortunes of wealthy individuals grow more rapidly than average income, the
capital/ income ratio will rise indefinitely, which in the long run should lead
to a decrease in the rate of return on capital. Nevertheless, this mechanism
can take decades to operate, especially in an open economy in which wealthy
individuals can accumulate foreign assets, as was the case in Britain and
France in the nineteenth century and up to the eve of World War I.[14]

The second
force “that can avoid an indefinite inegalitarian spiral and stabilize
inequality of wealth at a finite level” appears in the very next, rather
bizarre sentence, which the reader can judge as he likes: “In principle, this
process always comes to an end (when those who own foreign assets take
possession of the entire planet), but this can obviously take time.”

The
following example illustrates the kind of situation Piketty believes must
result from the capitalists accumulating capital more rapidly than the economic
system is able to grow. Thus, assume that initially the economy-wide ratio of
accumulated capital to national income is 3, and that the rate of profit on
capital is 5 percent. In this case, the capitalists will receive 15 percent of
the national income, that is, 5 percent on capital that is 3 times the size of
national income. At the same time, the wage earners will receive the remaining
85 percent of the national income.

Now assume
that the capitalists start saving out of their profits and after some time
succeed in doubling the economy-wide capital/income ratio to 6. If there were
no fall in the rate of profit, 30 percent of national income would now go to
the capitalists, leaving only 70 percent for the wage earners. In a situation
of little or no growth in the overall total of what is produced, the wage
earners would clearly lose out in such a case. The change in the percentage
distribution would represent the capitalists getting more and the wage earners
getting less in absolute terms, not just relative terms.

Piketty is
willing to allow for some fall in the rate of profit. However, he believes that
the fall in the rate of profit will be less than the increase in the
capital/income ratio. Thus, for example, if the rate of profit falls, say, to 4
percent, the doubling of the capital/income ratio will still have succeeded in
raising the capitalists’ share of national income from 15 percent to 24 percent
(4 percent on capital that is 6 times the size of national income), while
correspondingly reducing the wage earners’ share from 85 percent to 76 percent.
Once again, if there is little or no economic growth, this outcome will still
represent a gain for the capitalists at the expense of an equivalent or almost
equivalent loss on the part of the wage earners. The possibility of capital
accumulation itself resulting in growth is simply ignored, on the basis of
Piketty’s conviction that the capital/income ratio and capital goods play no
necessary role in production. Recall, it is “structural growth, driven by
permanent and durable growth of productivity,” that produces growth, according
to Piketty, not capital accumulation.[15]

Thus, in
the conditions of little or no growth, any significant change in income shares
means a more-or-less equivalent change in real incomes. In other words, as the
capitalists accumulate capital, according to Piketty, they get more and more,
and the workers get less and less.

Piketty
notes that “economic growth was virtually nil throughout much of human history:
combining demographic with economic growth, we can say that the annual growth
rate from antiquity to the seventeenth century never exceeded 0.1– 0.2 percent
for long.” (p. 353.) It must be observed that according to Piketty’s theory of
r > g as the basis of capital accumulation relative to income, this period
should have been one of enormous capital accumulation relative to income,
because not only was the rate of growth very low, but the rate of profit was substantially
higher than in modern times. Thus, nothing should have been easier than for
savings out of that high rate of profit to surpass the low rate of growth of
the period.

Of course,
the period was certainly not characterized by capital accumulation. Barbarian
invasions followed by centuries of feudal warfare and general insecurity of
private property, to which was added the short-range mentality that prevails in
an era ruled by fear and superstition, prevented any significant capital
accumulation over the period as a whole. Indeed, it was probably not until the
15th century that Europe attained the economic level that had been achieved
in antiquity. It is clear from economic history that in and of itself, the
excess of r over g implies absolutely nothing about capital accumulation. It is
surprising that not only Piketty, but all of his admirers seem not to have
noticed this gaping hole in the application of his theory to history.

Piketty
believes that today, i.e., since the 18th century, the long-run,
normal rate of growth is between 1 and 1.5 percent and “that a per capita
output growth rate on the order of 1 percent is in fact extremely rapid.”[16] Not surprisingly, it apparently
does not occur to Piketty to credit the relatively sharp increase in the growth
rate since the 18th century to capitalism and its underlying values:
most notably, reason, freedom, and the security of property, which values gave
rise to a substantially higher capital/income ratio and a continuing wave of
productive innovation. And, of course, a growth rate of 1 or 1.5 percent is
much less than the rate achieved in the United States from its founding up
until the last forty years or so.

In order to
establish that capital accumulation results in an increase in the share of
national income going to the capitalists and an equivalent decrease in the
share going to the wage earners, Piketty needs to show why increases in the
capital/income ratio should be expected to be greater than any accompanying
decline in the rate of profit on capital. If, for example, a doubling of the
capital/income ratio were accompanied by a halving or more in the rate of
profit on capital, the share of income going to the capitalists would not
increase; it would stay the same or fall, while the share going to the wage
earners would stay the same or rise. Thus, it is vital for Piketty to show why
a rise in the capital/income ratio should exceed any accompanying fall in the
rate of profit on capital.

This is his
demonstration:

As for capital’s share in national
and global income, which is given by the law α = r × β [Translation: capital’s
share of the national income equals the rate of profit on capital times the
capital/income ratio—GR.], experience suggests that the predictable rise in the
capital/income ratio will not necessarily lead to a significant drop in the
return on capital. There are many uses for capital over the very long run, and
this fact can be captured by noting that the long-run elasticity of
substitution of capital for labor is probably greater than one. The most likely
outcome is thus that the decrease in the rate of return will be smaller than
the increase in the capital/income ratio, so that capital’s share will
increase.[17]

The reader
should observe that Piketty has now declared, “There are many uses for capital
over the very long run, and this fact can be captured by noting that the
long-run elasticity of substitution of capital for labor is probably greater
than one.” Amazingly, these “many uses” in which capital can be substituted for
labor, i.e., result in the same output that until now required labor, allegedly
still do not constitutecases in which
capital accumulation contributes to economic growth, despite the fact that
production undeniably increases when capital takes the place of labor and the
displaced labor serves to increase production elsewhere. The same contradiction
appears on pp. 223-224, where Piketty asserts, “because capital has many uses,
one can accumulate enormous amounts of it without reducing its return to zero.”
Yet none of these uses appears to be that of increasing production in the
economic system and thereby raising the rate of growth.

Piketty
needs these references to capital’s productive contribution in order to
establish his case that a rise in the capital/income ratio will result in an
increase in the share of income going to capitalists. At the same time, he
needs to deny the productive contribution of capital in order to maintain his
views about what does and doesn’t cause growth and his belief that the overall
amount of real income will not grow significantly as capital accumulates. This
last is essential to his claim that the capitalists will be gaining more and
more at the expense of the wage earners. If Piketty acknowledged that the
increase in capital resulted in correspondingly increasing output, his whole
case about ever-increasing economic inequality would fall away. That case, as
he describes it, depends on the excess of the rate of profit over the rate of
growth. The greater this excess, the easier it is, he alleges, for the
capitalists to save at a rate that surpasses the rate of growth and thereby
launch “an indefinite inegalitarian spiral.”[18] But if the saving of the
capitalists results in corresponding economic growth, that inegalitarian spiral
cannot get off the ground.

So Piketty
cannot admit that capital accumulation in fact contributes to growth. But he
needs capital to make a substantial productive contribution in order to
establish the need for so much more of it that any fall in the rate of profit
will be more than offset by the increase in the amount of capital.

So, what he
does is implicitly acknowledge the productive contribution of capital and then
immediately forget that he has done so. That way, he can make a case for
substantial, indeed, limitless increases in the capital/income ratio taking
place with less than proportionate reductions in the rate of profit, while at
the same time arguing that they are not accompanied by any substantial economic
growth. This, of course, is a major contradiction: affirming the contribution of capital to production and denying the
contribution of capital to production.

Piketty is
concerned that there is no fixed limit to the rise in the capital/income ratio
and to the increase in the capitalists’ share of national income at the expense
of the wage earners’ share. He writes:

Where there is no structural growth,
and the productivity and population growth rate g is zero, we run up against a
logical contradiction very close to what Marx described. If the savings rate s
is positive, meaning the capitalists insist on accumulating more and more
capital every year in order to increase their power and perpetuate their
advantages or simply because their standard of living is already so high, then
the capital/income ratio will increase indefinitely. More generally, if g is
close to zero, the long-term capital/income ratio β = s / g tends toward
infinity. And if β [the capital/income ratio] is extremely large, then the
return on capital r must get smaller and smaller and closer and closer to zero,
or else capital’s share of income, α = r × β, will ultimately devour all of
national income.

Here one is
supposed to imagine the capital/income ratio rising perhaps to 10, then to 20,
50, 90, and even beyond, while the rate of profit falls to 3 percent, 2
percent, 1 percent, and below that. In this scenario, the profit share of
national income keeps on rising, to 30 percent (10 x 3 percent), then to 40
percent (20 x 2 percent), then to 50 percent (50 x 1 percent), and finally
perhaps close to 90 percent, leaving the wage share at 70 percent, then 60
percent, then 50 percent, and finally perhaps just 10 percent, or less.

He
continues:

The dynamic inconsistency that Marx
pointed out thus corresponds to a real difficulty, from which the only logical
exit is structural growth, which is the only way of balancing the process of
capital accumulation (to a certain extent). Only permanent growth of
productivity and population can compensate for the permanent addition of new
units of capital, as the law β = s / g makes clear. Otherwise, capitalists do
indeed dig their own grave: either they tear each other apart in a desperate attempt
to combat the falling rate of profit (for instance, by waging war over the best
colonial investments, as Germany and France did in the Moroccan crises of 1905
and 1911), or they force labor to accept a smaller and smaller share of
national income, which ultimately leads to a proletarian revolution and general
expropriation. In any event, capital is undermined by its internal
contradictions.[19]

Allow me to
point out a different “logical exit” from the rate of return on capital
allegedly having to approach zero or “capital’s share of income” coming to
“devour all of national income” than “structural growth.” The real “exit” is
the realization that the alleged saving of capitalists resulting in ever
increasing capital/income ratios simply
does not and cannot take place.

Contrary to
Piketty, capitalists do not “insist on accumulating more and more capital every
year” and certainly not “in order to increase their power and perpetuate their
advantages or simply because their standard of living is already so high.” They
save insofar as doing so is necessary to achieve the balance they desire
between provision for the future and present consumption. Once that balance is
achieved, they stop saving.

For
example, imagine a wealthy capitalist earning a 4 percent rate of return on a
fortune of $100 million of invested capital, and who is currently consuming his
full income of $4 million per year. He does not consume less and thus increase
his capital further, because he is satisfied with the fact that his fortune is
sufficient to support 25 years’ worth of such consumption. Adding $1 million to
his provision for the future at the expense of reducing his present consumption
by $1 million would add less to his state of well-being than the reduction in
his consumption would take away from it. The result is that he doesn’t save any
more than he has already saved. He is stopped from saving more by his time preference, i.e., his preference
for present consumption over further provision for the future.

Given his
state of time preference, what is necessary to make this capitalist save more
is an increase in his income, so that his income exceeds the $4 million that he
has judged he can afford to consume. If, for example, at the end of a year, it
turns out that he has earned a 10 percent rate of return, that is, an income of
$10 million, instead of $4 million, his consumption of $4 million implies current
saving of $6 million. Next year his capital of $106 million, together with a continuing
income of $10 million and a time preference that limits his accumulation of
capital to 25 times his current consumption, will imply a consumption of $4.24
million and saving of $5.76 million. These savings by the capitalist do not
increase the ratio of his capital to his income compared with what it was
initially. Indeed, the increase in his income has served sharply to reduce the ratio of his capital to his
income. That ratio was 25:1 ($100 million of capital to $4 million of income).
Now it is little more than 10:1 ($106 million of capital to $10 million of
income.) If his income were now to be permanently $10 million per year, many
years of heavy saving would be necessary to restore the 25:1 ratio of
accumulated capital to income. He would have to save to the point that his
capital grew to $250 million. At that point, a 4 percent rate of annual
consumption relative to his accumulated capital would exhaust the $10 million
of income, and further net saving would come to an end.

None of the
saving necessary to increase this capitalist’s capital from $100 million to
$250 million constitutes an increase in the ratio of his capital to his income
compared with the initial value of that ratio. It is necessary in order merely
to reestablish the previously prevailing
ratio in the face of a now higher income. It is what is necessary for his
fortune to be sufficient for 25 years of his consumption in conditions in which
his consumption would rise to the point of exhausting his now higher income.

Piketty has
it all wrong. The saving of capitalists does not continually raise the
capital/income ratio and then require “structural growth” unconnected with
capital accumulation and that may or may not occur, in order to prevent the
capital/income ratio from rising without limit. To the contrary, the saving is
the result of a rise income and is necessary to reestablish the same ratio of
capital to income that must prevail in order for consumption of the whole
income to be consistent with a given ratio of provision for the future relative
to present consumption.

Of course,
any rise in the ratio that the capitalists choose between their capital and
their consumption, i.e., in this case, a rise beyond the 25:1 ratio, would
cause an increase in production and contribute to more rapid economic progress,
Piketty to the contrary notwithstanding. But, as I have explained, there is
always a point where time preference prevents the capitalists from further
increasing this ratio, and there is absolutely no reason for assuming, let
alone for fearing, any unending fall in time preference on the part of the
capitalists.

Piketty’s
essential thesis is that capitalism operates to increase profits at the expense
of wages, and that it does so through the accumulation of ever more capital
earning an ever larger share of the national income as profit and
correspondingly reducing the share of national income remaining as wages. Moreover,
as already shown, the reduction in wages is allegedly not merely in terms of
money and the wage earners’ share of national income, but also in real terms. According
to Piketty, this is because the accumulation of capital does nothing to
increase the total of what is produced, with the result that a lower wage share
means less actual goods and services going to wage earners.

As I have explained,
the truth is that the higher is the ratio of capital to income, the more
receptive is the economic system to the adoption of technological advances and
thus the more capable it is of achieving increases in production. The increases
in production, of course, are increases not only in the production of
consumers’ goods but also in the production of capital goods. The increased
production of capital goods then makes possible the further adoption of
technological advances and still further increases in the supply both of
consumers’ goods and capital goods, in a process that can continue without
fixed limit.

The result is
a steady rise in the productivity of labor, which continually increases the
supply of goods produced relative to the number of workers producing them. The
effect of this is a steady fall in prices relative to wages, a fall which
occurs even in the midst of an increasing quantity of money and volume of
spending great enough to raise prices; in this case, the rise in money wage
rates outstrips the rise in prices, with the result that prices still fall
relative to wages. In other words, the effect is a continuing rise in real
wages and the average standard of living.

Furthermore,
in full contradiction of Piketty, it should be realized, that, by its nature,
capitalism operates to increase the share
of national income going to wages while reducing the share going to profits. A
rise in the capital/income ratio results in exactly this outcome.

These
conclusions can be demonstrated by means of a simple example.

Thus,
assume that initially the total amount of profit in the economic system is 200
units of money. (Each unit can be conceived as representing as many tens of
billions of dollars as may be necessary for 200 units to equal the actual
current amount of aggregate profit.)

Assume also
that accumulated capital in the economic system is initially 2,000 units of
money. Thus the initial average rate of profit is 10 percent.

And,
finally, assume that the capitalists, who up to now been spending their 200 of
profit on consumers’ goods, decide to save and invest half of it and make an
additional expenditure for capital goods and labor in the amount of 100.

Whatever
portion of this 100 is wage payments necessarily increases the total of wages
paid in the economic system. At the same time, the spending of an additional
100 on capital goods and labor must sooner or later add 100 to the aggregate
costs of production of business that are deducted from sales revenues, thereby
equivalently reducing aggregate
profits.

The rise in
aggregate costs can take place immediately or over many years, depending on
what the 100 is spent for. At one extreme, if it were spent entirely on items
that were not capitalized, such as, typically, selling, general, and
administrative expenses, it would show up immediately as equivalent additional
costs. At the other extreme, if it were spent entirely on the construction of
buildings with a forty-year depreciable life, it would take forty years for it
to show up as equivalent additional costs of production. But one way or the
other, sooner or later, it will show up as equivalent additional costs and thus
equivalently reduce the amount of profit in the economic system.

Thus,
Piketty’s “findings,” as they are called, are reversed. The capitalists’ saving
and investment that increases the ratio of accumulated capital to income, increases the wage share of national
income and decreases the profit share.

It needs to
be pointed out, if it is not already apparent, that the higher aggregate costs
that result from the capitalists’ reducing their consumption and increasing
their expenditure for capital goods and labor is the foundation of lower and
progressively falling unit costs. This is because, as shown, it is the
foundation of an increase in production, including the production of capital
goods. Growing quantities of goods divided into expenditures that are higher
but then stable at the higher level result in progressively falling unit costs
and prices.

Furthermore,
when the capitalists reduce their consumption and step up their saving and
investment, the rate of profit falls
not only by virtue of the resulting fall in the amount of profit in the
economic system, but also by virtue of the increase in accumulated capital that
takes place. This last is a result that is particularly ironic, in that Piketty
counts on the increase in the amount of accumulated capital to offset the
effect of a fall in the rate of profit. He never imagines that the increase in
the amount of accumulated capital could instead itself contribute to a fall in
the rate of profit. (Remember the examples of the rate of profit declining from
5 percent on down to 1 percent, but accompanied by increases in accumulated
capital great enough to nevertheless allegedly increase the profit share of
national income?)

In reality,
the average rate of profit in the economic system is never something that
exists independently of the amount of accumulated capital, as Piketty believes.
To the contrary, the average rate of profit reflects the amount of accumulated
capital operating as the denominator in a fractional expression in which the
amount of profit serves as the numerator. To whatever extent the capitalists’
additional expenditure for capital goods and labor serves to increase the
amount of accumulated capital, it serves to join with the reduction in the
amount of profit in the economic system to further reduce the average rate of
profit.

Thus, in
the example of an increase of 100 in expenditure for capital goods and labor, assume
that by the time costs of production rise by 100, the accumulated capital of
the economic system doubles from 2,000 to 4,000. In that case, the rate of
profit would fall not merely to 5 percent, reflecting the halving of the amount
of profit, but to 2.5 percent, reflecting the additional fact of the
accumulated-capital-denominator having doubled. And the greater the increase in
accumulated capital accompanying the reduction in the amount of profit, the
lower is the rate of profit. If the accumulated capital somehow increased to
5,000, the average rate of profit would be just 2 percent. If it increased to
10,000, the average rate of profit would be just 1 percent.

Thus, ironically,
the rise in the capital/income ratio, which Piketty has assumed will be great
enough to more than offset the fall in the rate of profit that accompanies it
and thereby result in an increase in the amount of profit in the economic
system, instead works in the opposite
direction. It serves to compound the effect of the fall in the in the
amount of profit that accompanies a rise in the capital/income ratio. The
greater the additional capital accumulated in connection with the rise in
expenditure for capital goods and labor, the
greater is the fall in the rate of profit.

Had he
known the actual effects of a rise in the capital/income ratio on the amount
and rate of profit, Piketty might have written a book featuring the old
standard Marxist scare of an allegedly ever-falling rate of profit as the
result of capital accumulation. But then he would have had to give up his
thesis concerning profits accounting for an ever growing share of national
income as the result of capital accumulation.

Having
raised the specter of the rate of profit falling as capital accumulates, it is
necessary for me immediately to put it to rest. What stops any such process is
time preference. Even though there is now a lower time preference, as manifested
in the fall in the capitalists’ consumption from 200 monetary units to 100
monetary units, there is still time preference. And consistently with the new,
lower time preference, the accumulation of additional capital will give rise to
additional consumption on the part of the capitalists. Thus, with a degree of
time preference calling for provision for 20 years of consumption at the rate
of 100 monetary units of consumption per year (20 years is the figure implied
by the assumed accumulated capital of 2,000), capital accumulation cannot
proceed to the point of doubling the amount of accumulated capital while the
consumption of the capitalists remains unchanged. Long before that point were
reached, their consumption would increase in pace with the accumulation of
additional capital. The original additional expenditure for capital goods and
labor would be scaled back as the capitalists’ consumption rose. Additions to
accumulated capital would come to an end through a joint process of costs of
production rising toward a level of new and additional expenditure for capital
goods and labor that was itself diminishing. A new equilibrium would be
achieved, perhaps with total accumulated capital in the economic system of 3,000
and consumption on the part of the capitalists of 150.

Compared
with the starting point, this would still represent a fall in the amount of
profit and the average rate of profit, accompanied by an increase in the
capital/income ratio and a rise in the share of national income that is wages.

Thus,
contrary to Piketty, there is simply no possibility of an increase in the share
of profit and decrease in the share of wages in the economic system being an
accompaniment of a fall in the capitalists’ time preference and the consequent
rise in the capital/income ratio. Accordingly, there is no possibility of
capital accumulation serving to enrich the capitalists at the expense of the
wage earners. The exact opposite is true. The effect of the capitalists’
activities is both to increase the share of national income going to wage
earners and to progressively increase the productivity of labor. The further
effect is a continuing fall in prices relative to wage rates, and thus a
progressive rise in real wage rates.

Nor,
finally, is there any danger of capital accumulation serving to reduce the rate
of profit toward zero or anywhere close to zero, as Piketty’s guiding light
Marx maintained. Contrary to Piketty, the capitalists do not “dig their own
grave.” There is no perpetually falling rate of profit that compels them to “tear
each other apart in a desperate attempt to combat [it].” Nor do they “force
labor to accept a smaller and smaller share of national income, which
ultimately leads to a proletarian revolution and general expropriation.” In no event
is capital “undermined by its internal contradictions.”[20] But Piketty is certainly undermined
by his contradictions and errors. He
is off by 180 degrees.

Previous
discussion implies that time preference imposes limits on saving and the height
of the capital/income ratio. It is necessary to reconcile this truth with the
observable fact that in almost every year fresh net saving and net investment take
place and that as a result the overall value of accumulated capital continues
to increase.

The
reconciliation is simple. Continual fresh net saving and net investment, and
consequent continual increases in the value of accumulated capital, are the
result of continual increases in the
quantity of money and volume of spending in the economic system. The increase in spending raises
profits and wages. Profits are increased above the level of consumption
dictated by time preference and previously accumulated capital. All or almost
all of the increase is saved and invested, in order to maintain the
relationship between capital and consumption imposed by time preference, just
as in the example given earlier of the capitalist whose rate of profit
increased from 4 percent to 10 percent on his $100 million fortune. In the same
way, the rise in wages increases the incomes of wage earners relative to their
pre-existing provision for the future in the form of accumulated savings. If
they wish to maintain the same relationship between their now higher incomes
and their savings, they need to increase their accumulated savings, which
requires that they engage in saving out of income.

Thus, it is
not a perpetually falling time preference that keeps net saving and net
investment in being, but the increase in the quantity of money and volume of
spending. Time preference can remain the same indefinitely and net saving and
net investment continually go on alongside the unchanged time preference,
simply because of the increase in the quantity of money and volume of spending
raising money incomes.

(This, of
course, does not mean that flooding the economic system with new and additional
money would result in a massive increase in the rate of saving. To the extent
that that the purchasing power of money would be threatened by such a policy,
its result could well be a reduction in saving in terms of that money, as
people lost their desire to hold it or to enter into contracts payable in it.)

Piketty has
it backwards when he assumes a positive rate of saving that is both permanent
and independent of the rate of growth. Growth—i.e., in the present context,
growth in the quantity of money and volume of spending in the economic system,
and consequently in money income—is what is responsible for the continued
existence of net saving and net investment. Stop the increase in the quantity
of money and volume of spending, and net saving and net investment in terms of
money both come to an end, just as they did in the above example of the
capitalists reducing their consumption expenditure by 100 and increasing their
expenditure for capital goods and labor by that amount.

The rate of
saving is not a long-run fixed independent variable in search of causeless,
fortuitous growth. To the contrary, growth in the quantity of money and the
resulting increase in money income is the independent variable that
necessitates saving out of income in order to maintain any given capital/income
ratio. To reverse an example that Piketty uses, a growth rate of 2 percent in
terms of money income is what necessitates a savings rate of 12 percent if a
capital/income ratio of 6 is to be maintained. It is not at all the case that
the starting point is a 12 percent rate of saving that would lead to an
infinite capital/income ratio in the absence of fortuitous income growth.[22]

Thus, Piketty’s
alleged “Second Fundamental Law of Capitalism: β = s / g,” viz., his
proposition that the capital/income ratio tends to equal the rate of saving (s)
divided by the rate of growth (g), collapses.[23] It collapses, firstly, because in
the absence of increases in the quantity of money and volume of spending, the necessary
long-run values of both s and g in terms of money are zero, while that of the long-run
capital/income ratio is a constant determined by the state of time preference.
It collapses, secondly, because in the presence of increases in the quantity of
money and volume of spending, it is the value of g (here the rate of growth in
the quantity of money and volume of spending) together with the relationship
between capital and consumption determined by the prevailing state of time
preference, that determine s. Again, s is not any kind of fixed, independent
variable. It is the product of the increase in the quantity of money and volume
spending coupled with the prevailing state of time preference as manifested in the
ratio of capital to consumption.

To
reinforce recognition of the role of the money supply in the continued
existence of net saving and net investment, it should be realized that the
increase in the quantity of money and volume of spending operates
systematically to add equivalent sums both to the amount of profit in the
economic system and to the amount of net investment in the economic system.
When it stops, those additions sooner or later cease.

Profit is
sales minus costs. Aggregate profit is the difference between the total of all
business sales revenues in the economic system and the total of all the costs
of production deducted from those sales revenues. Net investment is the
difference between productive expenditure
and those very same costs.

Productive
expenditure is the expenditures business firms make for capital goods and
labor. These expenditures constitute additions to the capital assets of firms
insofar as they take the form either of expenditure for buildings, plant, and
equipment or expenditure on account of inventory and work in progress. Costs of
production in the form of depreciation cost and cost of goods sold constitute
subtractions from the capital assets of firms. The difference between the
additions constituted by productive expenditure and the subtractions
constituted by costs of production is the net change in those assets, i.e., net
investment.[24]

In the
presence of an increasing quantity of money and volume of spending, costs of production
necessarily lag behind productive expenditure. This is what perpetuates the
existence of net investment. Costs of production reflect the smaller levels of
productive expenditure made in earlier periods of time. Today’s productive
expenditure is greater than last year’s and next year’s will be greater still. Costs,
reflecting the lower productive expenditures of prior years cannot catch up to
current productive expenditure when that expenditure is rising.

The amount
of profit in the economic system reflects the amount of net investment
virtually dollar for dollar. This is because not only are the subtrahends—i.e.,
the costs of production that are deducted the same in both cases. But also the
minuends—i.e., in the one case the amount of sales revenues and in the other
the amount of productive expenditure—are not very different. One component of
productive expenditure is the expenditure for capital goods. That expenditure
is also an identical component of sales revenues. What one firm spends in
buying capital goods, other firms equivalently receive in selling those capital
goods. E.g., what Ford spends for capital goods in buying steel sheet, the
sellers of the steel sheet receive as sales revenues.

The other
component of productive expenditure, of course, is wage payments. One does not
go far wrong in assuming that those wage payments show up as the main source of
the remaining component of sales revenues, which is the funds brought in from
the sale of consumers’ goods. Thus, to the extent that productive expenditure
exceeds costs of production, thereby generating net investment, the sales
revenues generated by that productive expenditure exceed those costs of
production by the same amount. Thus the amount of profit in the economic system
reflects the amount of net investment.[25]

However,
sales revenues exceed productive expenditure. Since, as shown, expenditure for
capital goods is a component both of sales revenues and productive expenditure,
the excess of sales revenues over productive expenditure reduces to the difference
between the remaining components of sales revenues and productive expenditure.
That is, it equals the amount by which sales revenues constituted by
consumption expenditure exceed the wages paid by business and then consumed by
the workers who receive them.

The source
of this excess is the consumption spending of businessmen and capitalists,
financed by such means as dividend and interest payments and the draw of funds from
their enterprises by partners and sole proprietors. I call this excess net consumption.[26]

As can be
learned from virtually any textbook of “macroeconomics,” national income, in
addition to being the sum of profits plus wages, is also the sum of consumption
plus net investment, i.e., net national product. (Net national product differs
from GDP essentially just by the subtraction of depreciation allowances from
the latter.)

The actual
reason for this identity is simply a change in the order in which the
revenue/expenditure subcomponents that constitute national income and net national
product are added. To arrive at national income they are added by revenue type.
To arrive at net national product, they are added by expenditure type. Thus, in
national income, sales revenues include sales revenues both from consumers’
goods and sales revenues from capital goods. Wages include wages paid by
consumers (primarily the government) plus wages paid by business firms. In net
national product, the sales revenues paid by consumers are added to the wages
paid by consumers, to get consumption, while the wages paid by business are
added to the expenditure for capital goods to get productive expenditure. In
national income, costs are subtracted from sales revenues. In net national
product, they are subtracted from productive expenditure.

In the
prolonged absence of increases in the quantity of money and volume of spending,
and thus with the disappearance of net investment, the amount of profit in the
economic system comes to equal the amount of net consumption alone. At the same
time, with net investment equal to zero, national income reduces to equality
with consumption alone. With national income equal to consumption alone, there
is no saving.

Thus, a main
point of this section is proven. The continued existence of net saving and net
investment is the result of an increasing quantity of money and volume of
spending. The indefinitely continued saving and investment that is supposed to
increase capital/income ratios without limit, and that Piketty is worried
about, simply doesn’t exist. It is stopped by time preference. The indefinitely
continued saving and investment that does exist is the product of the increase
in the quantity of money and volume of spending. It operates merely in the
direction of reestablishing the long-term capital/income ratio corresponding to
the state of time preference, and that would exist in the absence of further
increases in the quantity of money. It does not operate perpetually to increase
that ratio. Indeed, as shown, the saving that takes place as the result of
increases in the quantity of money exists in a context in which the resulting
increase in profits and wages serves to reduce the capital/income ratio.[27]

It needs to
be realized that the net-investment/monetary component in profit and the rate
of profit is by no means necessarily an indication of inflation. (Inflation should
be thought of not as any increase in the quantity of money, but only as an
increase more rapid than the increase in the supply of gold/silver.) Under
capitalism and a gold standard, the increase in the quantity of money and
volume of spending would be fairly modest and the increase in the production
and supply of goods could easily equal or, indeed, exceed it, as it did
throughout the 19th century. In that case the increase in the quantity of money
and volume of spending would not result in rising prices and could actually be
accompanied by falling prices, as was the case in the 19th century. But to
whatever extent it existed, it would still figure in the rate of profit. There
would still be a net-investment/monetary component.[28]

It should
be apparent from this that while the rate of profit expressed in money,
contains an important component determined by nothing more than the rate of
increase in the quantity of money and volume spending, the real rate of profit,
i.e., the rate that reflects the rate of gain in terms of buying power,
contains a component equal to the rate of increase in the production and supply
of goods. If the rate of increase in production and supply equals or exceeds
the rate of increase in money and spending, prices remain stable or fall, with
the result that the additional monetary profit is also an additional real
profit. Under capitalism and a gold standard, the monetary component in the
rate of profit almost certainly represents a real profit, and very likely
understates it, to the extent that prices fall.

Insofar as
the real rate of profit consists of the increase in production, it obviously
benefits everyone, by no means just the capitalists. The overwhelming bulk of
the capitalists’ monetary gain here is merely a kind of marker, signifying the increase in wealth on its way to satisfying
the needs of the consumers and to serving in production for the future.
Moreover, as shown, the more the capitalists curtail their consumption in order
to save and invest, the larger is the share of the increasing supply of
consumers’ goods produced that goes to the wage earners.

The fact
that the increase in the quantity of money and volume of spending in the
economic system is responsible both for the continued existence of net saving
and for the addition of a corresponding positive component in the rate of
profit explains why the saving that takes place in the real world is not accompanied
by a falling rate of profit. In essence, no sooner does saving add to the value
of accumulated capital and the investment it finances add to aggregate costs of
production, than the continuing increase in the quantity of money and volume of
spending further increase productive expenditure, sales revenues, and profits.
Thus, as I wrote elsewhere, “the net saving that takes place as a regular,
continuing phenomenon in the economic system is the accompaniment of a rate of
profit which is not only not reduced by virtue of its existence, but in fact is
elevated by virtue of the same cause that underlies its existence. Thus,
insofar as net saving goes on for the most part, it is accompanied by a rate of
profit that is higher, not lower, than would exist in its absence. Indeed,
precisely the elevated rate of profit is the source of most of the net saving.”[29]

So much for
Piketty’s and Marx’s fears of saving driving the rate of return toward zero and
thereby representing a process by which the capitalists “dig their own grave.”

It is also
important to realize that profits and interest in the economic system are
artificially increased relative to wages and salaries by virtue of all government
intervention that prevents saving and investment. It’s been established that funds
that are saved and invested show up sooner or later in business income
statements as costs of production, thereby reducing the proportion of sales
revenues that is profit.

It follows
that insofar as taxes and government budget deficits serve to reduce the volume
of saving and investment in the economic system, they also serve to reduce the
aggregate costs of production that must be deducted from sales revenues in the
calculation of profits. Since aggregate sales revenues remain the same,
inasmuch as the rise in spending for consumers’ goods by the government offsets
both the drop in spending for capital goods and the drop in spending for
consumers’ goods by wage earners resulting from the fall in wages paid by business
firms, the effect is an equivalent rise in the amount of profit in the economic
system and a corresponding rise in the average rate of profit. And since it is
profit that governs interest, the amount and rate of interest also increase.

It further follows
from the above that Piketty’s program of confiscatory taxation of income and
capital is a program for decreasing wage payments and expenditures for capital
goods, and thus the costs of production deducted from sales revenues, and
therefore, for increasing the amount and rate of profit in the economic system.
It is also a program for progressively reducing the supply of capital goods and
thus the productivity of labor, real wages, and the general standard of living.

In
addition, it turns out that for the capitalists themselves to increase the
profit share and decrease the wage share of national income, they would have to
do the exact opposite of what Piketty
fears them doing. Namely, not saving and investing, but dissaving and consuming. If the time preference of the capitalists
rose, and they stepped up their consumption expenditure by means of using funds
made available by reducing their expenditure for capital goods and labor, the
costs of production deducted from sales revenues would sooner or later fall to the
same extent, and profits would rise equivalently. Of course, as a result of the
greater expenditure for consumers’ goods relative to the expenditure for
capital goods, the production of consumers’ goods would increase at the expense
of the production of capital goods. The further result would be a reduced
ability to produce either consumers’ goods or capital goods in the future,
owing to the reduction in the supply of capital goods that would be caused by the
measures he proposes.

If the
shift in the relative production of capital goods and consumers’ goods went to
the point where the production of capital goods was no longer sufficient to
replace the capital goods being used up in production, production, including the
supply of capital goods produced, would shrink from year to year. The economic system
would be thrown into a state of retrogression.

The actual
relationship between profits and saving was understood by Adam Smith, who
wrote: “But therateof profit does not, like rent and wages,rise with the prosperity, and
fall with the declension of the society. On the contrary, it is
naturally low in rich, and high in poor countries, and it is
always highest in the countries which are going fastest to ruin.”[30]

Piketty is out to illustrate the truth
of Adam Smith’s proposition by means of pushing the United States, and as much
of the rest of the world as may be foolish enough to adopt the policies he
recommends,substantially further in the
direction of “going fastest to ruin.” He knows so little about the rate of
profit and its determinants that he believes that the greater is the excess of
the rate of profit over the rate of growth, the greater is the danger posed by saving
by the capitalists.[31] In fact, what is signified is the exact
opposite, namely, a level of consumption by the capitalists so high and a level
of saving and investment by the capitalists so low, that growth cannot take
place and is replaced by economic decline.

A critique of Piketty would not be
complete without dealing with his hostility to the high pay of CEOs and other
key executives of business firms.[32]

In 2012, the median income in the
United States was approximately $51,000. In that year, six CEOs earned in
excess of $51 million, i.e., 1,000 times as much. Piketty believes that it is grossly
unjust if an executive earns 100 times the average income.[33]

I will waste no time here justifying
100:1 inequalities. Instead, I will straightaway justify 1,000:1 inequalities
as represented by the earnings of the country’s highest-paid CEOs.

These CEOs are responsible for
directing the labor of tens of thousands of workers and the use of tens of
billions of dollars of capital. They decide what these workers produce and how
they produce it. Thus, their decisions have enormous consequences. It is
reasonable that they be remunerated on a scale commensurate with the scale of
their decisions. A $50 million dollar income for a CEO is just 1 percent of $5
billion of capital or $5 billion of sales revenue, and the capitals and sales
revenues they are actually responsible for are much greater. Money managers
routinely earn a higher percentage of the capital they manage. Real estate
brokers typically earn 6 percent of the price of the houses they sell. At a
rate of remuneration of just 1 percent, indeed, less than that, to the extent
that the amounts of capital and sales revenues actually involved are more than
$5 billion, these CEOs are arguably underpaid.

Most important, it is essential that
the decision-making power of CEOs be guided by their having a major ownership
stake in the firms they direct. To function properly, they need to be motivated
not only by the desire to make profits but also by the desire to avoid losses.
To experience that desire, as it needs to be experienced, they need to have a
major ownership stake in the firms they run. The high incomes they are paid are
the means of their acquiring that stake. Typically, much or most of their
income is paid to them in the form either of company stock or options to buy
company stock.

Ironically, in CEOs and other key
executives earning extremely high incomes, capitalism operates to accomplish
something that the alleged champions of workers’ rights and “social justice” might
be thought to favor. Namely, it accomplishes a transfer of a significant part
of the ownership of the means of production from more or less passive
capitalists to the workers who are doing the actual job of running the firms,
i.e., those workers who are providing the overall, guiding, directing
intelligence in the firms’ operations, and who, in just payment, now become
substantial capitalists. Of course, as the result of the powerful ownership
incentives given to those running the firms, the passive capitalists can expect
to do better than they would have done otherwise.

In serving to make possible the
acquisition of a substantial ownership stake in their firms, the high incomes
of CEOs and other key executives solve another problem long lamented by the
left. Namely, the alleged separation of ownership and control, a problem cited
as far back as 1932 by Berle and Means.[34] To the extent that this problem is real (and
confiscatory income and inheritance taxes operate to make it real), it is
solved by the high incomes of the executives. For their resulting ownership
stakes mean that ownership is being given to those who have control.

Yet another complaint of the critics
of capitalism is resolved, namely, the alleged impossibility of starting new
firms requiring substantial sums of capital, such as a new automobile company.
The high incomes of key executives, largely saved and invested, could provide
the core of the capital necessary for such investments. For example, ten or
twenty key executives in an existing automobile company might well be in a
position to accumulate several hundred million dollars between them over the
years, and thus, perhaps with the aid of bank loans, be in a position actually
to start such a new company. Their accumulations would be the more assured if
there were no personal income tax.

Finally, consistent with the scale of
their activities, from time to time CEOs find that the services of thousands of
the workers their firms employ are no longer necessary. This is the case, for
example, when advances in technology and capital equipment make it possible to
achieve the same results with less labor. The saving of this much labor is an
enormous productive contribution not only from the point of view of the firms
the CEOs work for, and for the stockholders of these firms, but also from the
point view of the economic system as a whole, and the average member of the
economic system, because the workers no longer needed by these firms are now
available for achieving an overall expansion in production in the economic
system, as and when they become employed elsewhere. Along with this, the funds
no longer required to pay their wages are available to pay wages elsewhere in
the economic system.

These CEOs certainly deserve to be
well rewarded for such substantial productive contributions. At the same time,
however, the workers they’ve dismissed will temporarily be unemployed and worse
off. There is nothing at all unjust in any of this. The CEOs and their former
employees are not members of the same nuclear family destined to share good
times and bad together. They are separate, independent parties, each with
distinct self-interests, but each with the common self-interest that all of
them be free peaceably to pursue their self-interests, the operation of which
principle serves to progressively increase the standard of living of everyone.
If and when the workers laid off succeed in finding other jobs paying as much
as the jobs they lost, they will benefit, in their capacity as consumers’
paying lower prices, even from the improvement that displaced them. And they
certainly benefit from all other labor-saving improvements that take place,
have taken place, or will take place, anywhere in the economic system. In
increasing the supply of products produced relative to the supply of labor that
produces them, and thereby reducing prices relative to wage rates, such
improvements are the foundation of all the increases in the general standard of
living that have taken place or will take place.[35]

When it
comes to the subject of economic inequality, Piketty lives in a world of 19th
century novels. He has dozens of references to the novels of Jane Austen and
Honoré de Balzac, in which the role of inherited wealth is prominent. He
believes that the world of these novels is the world of capitalism, in
contradiction of the fact that in the foremost capitalist country, the United
States, the great fortunes of every generation have not been the product of
inheritance but were earned by those
who owned them. The fortunes of Astor, Vanderbilt, Carnegie, Morgan,
Rockefeller, Ford, and, in our day, Gates and Buffett, were not inherited. They
were built by these men. And the
wealth of the heirs steadily recedes in relative size as the major innovators of
the next generation appear on the scene and build still greater fortunes.

Piketty and
the rest of the egalitarian movement know nothing of how great fortunes are
acquired under capitalism, nor of their economic significance. The fact is, they
are built by means of earning very high rates of profit for many years, and
saving and reinvesting the overwhelmingly greater part of those profits. This
is what makes possible the very high compound rates of growth over many years
that are necessary to go from relatively modest initial investments to great
fortunes later on.

To earn the
high rates of profit, important innovations are necessary, most notably, the
introduction of newer, better products or more efficient, lower-cost methods of
producing existing products. And because a high rate of profit attracts
competitors, whose competition then brings down that rate of profit toward the
general or average level, it is almost always necessary for the fortune
builders to introduce further innovations, in order to maintain their high rates
of profit.As a rule, it is necessary
for them to introduce a whole series of innovations over the period in which
they are building their fortunes.

And as the
profits are saved and reinvested, the effect is that the fortunes serve in
delivering the benefit of the innovations to the general buying public, for
they are used to produce the products that bear the innovations. Thus, for
example, Rockefeller’s fortune was made by steadily reducing the cost of
production and price of petroleum products and widening the range of petroleum
products produced. As his fortune grew, it was used in building the oil
refineries and pipelines and other means of production that brought the
improved and more efficiently produced supply of oil products to the general buying
public. Thus, both in its origin in high profits, and in its disposition, in
capital investment, his fortune provided immense benefits to the general buying
public.

The same
was true of the great fortune of Henry Ford, who started with a capital of
$25,000 in 1903 and died with a capital of $1 billion in 1946. What earned that
fortune were such major innovations as the moving assembly line and interchangeable
mass produced parts and being able to reduce the cost of producing automobiles
and improve their quality to the point that in the 1920s one could obtain a far
better automobile for $300 than one could obtain for $10,000 early in the
century. The profits Ford made from his innovations were overwhelmingly plowed
back into the Ford Motor Company, where they showed up as the factories,
assembly lines, equipment, and supplies necessary to produce millions of such
new cars.

Even though
these truths are virtually self-evident, once named, egalitarians are unaware
of them. They take the products of capitalism for granted, with no more idea of
how they came into existence than Piketty has when he imagines an economy
functioning, indeed, growing, without the use of any capital whatsoever.[36] Indeed, the truth is that
egalitarians view capital and capital goods as though they were consumers’
goods, that is, as goods whose benefit goes exclusively to their owners and that
can be of benefit to those not fortunate enough to be their owners, only by
virtue of the latter becoming their owners.

The
egalitarians do not recognize the simple truth that in a capitalist economy it
is not necessary to own capital or capital goods in order to get their benefit.
All that is necessary is that one be free to buy the products. Whoever buys gasoline or heating oil, for
example, gets the benefit of oil refineries and pipelines. Whoever buys or
rents an automobile gets the benefit of automobile factories and steel mills.
Under capitalism and its production for the market, everyone gets the benefit
of the capitals owned by others. He gets that benefit when he buys the products
of those capitals.

Moreover,
closely related to this benefit of privately owned capital to the general
buying public, is the fact that privately owned capital is the source of the
demand for the labor of the average person. It is the source both of the supply
of the goods that he buys and of the demand for the labor that he sells. It is
this demand for the labor of non-owners of the means of production, of course,
that makes possible their purchases.

Thus, even if
he personally did not own any means of production, the average member of
society would still receive the overwhelming bulk of the benefit of the
existence of the means of production. He receives it in his capacity as a buyer
of products and seller of labor.

To be sure,
it is more desirable to be a wealthy capitalist than just an average worker.
But the actual difference is much less than is assumed. It is not measured
either by the size of the capitalist’s capital or by the size of his profit.
The advantage constituted by his capital is almost entirely of a psychological
nature. It is the knowledge that it is there if he needs it. Normally, his
capital is not to be touched, but augmented, and when it is touched, it is
almost always to a relatively modest extent.

His profit
is also not the measure of his advantage. This is because, to the extent that
he saves and reinvests his profit, his profit, like the capital to which it is
now joined, serves the buyers of the products he sells and the wage earners
whose labor he buys. The actual, realized advantage of being a wealthy
capitalist is the extent to which it enables him to consume more than the average person. But even this greatly
overstates the extent of his direct personal benefit. This is because a major
portion of the consumption of a wealthy capitalist will likely be of a kind
that also operates to the benefit of a more or less substantial number of other
people, often including the entire society. This is the case to the extent that
his consumption takes such forms as financing scientific research,
universities, libraries, orchestras, opera companies, hospitals, and the like,
things which can be of the greatest personal value to an individual once he is
in a position in which he can afford to finance them. Just as a diamond can be,
and usually is, of greater personal value than a gallon of water, when one
already has all the water one needs for any purpose, so financing such things
can be of greater personal value than more of any of the usual items of consumption
when one already has all the usual items in great abundance.

Thus, when
all is said and done, the result is that in terms of actual, direct personal
consumption, the difference between rich and poor in a capitalist country, such
as the United States, is not all that great. Both have food, clothing, shelter,
indoor plumbing, electricity, telephones, television sets, automobiles,
refrigerators, and the like. The rich have more and better of these things, but
the “poor” have enough of them to be considered rich compared to most people in
most other countries and compared to everyone, even the very richest people in
the world a few generations back. Thanks to capitalism, a “poor” person in the
United States today is richer in terms of the goods available to him than Queen
Victoria was at the turn of the 20th century. He is richer in
practically every respect except the ability to afford servants.

The average
person is not capable of making great innovations and building new industries
or revolutionizing existing ones. But if he lives in a society in which private
property is secure, he gets their benefit all the same. All he needs to obtain
their benefit, is to have enough intelligence and knowledge to understand that
his economic well-being depends on those who are more capable than him having
the freedom peaceably to exercise their greater abilities. He needs to
understand that he has no right to any of the property of those who supply and
employ him, that seizing their property in the name of “social justice” and the
“redistribution of wealth and income” is anything but just—that it is theft and
can do no more good than a mob looting a store.

Each member
of such a mob can act in the belief that it is “just” that he take an item or
two from the store, which has so many items while he has so few. But the effect
will be that there will then be no store, with the result that everyone will
have much less than he otherwise would have had. Moreover, it makes no
difference if, instead of looting the store, the “redistributors” get the
government to tax the store or its owners and distribute the proceeds to those who
would have looted it and who can now buy what they otherwise would have looted.
In this case, the store started with its money and its goods, and ends with
just its money. That is exactly how it started and finished in the case of
being looted.

Piketty’s data
are flawed in four major respects. First, like practically everyone else who denounces
the growth of economic inequality, he gives insufficient recognition to the
role of government-sponsored credit expansion flooding into stock and real
estate markets and thereby driving up stock and real estate prices. Since, in
the nature of the case, these assets are owned to a much greater extent by
wealthy people than poor people, the effect is to increase the difference in
their economic positions accordingly.

Second,
again like practically everyone else who denounces growing economic inequality,
he never takes the time to discuss the extent of inequality after a stock or real estate market bubble
bursts, when many of the fortunes resulting from credit expansion are wiped out
and business firms throughout the economic system suffer sharply reduced
profits or even outright losses, and bankruptcies skyrocket.

Third, and
this is an even greater flaw, his estimates of the amount of capital in the
economic system are systematically inflated by a factor of two. This is because
he includes in capital, owner-occupied housing, which he describes as
accounting “for half of total national wealth.” “Residential real estate,” he
says, “can be seen as a capital asset that yields `housing services,’ whose
value is measured by their rental equivalent.”[37]

Now, in
fact, owner-occupied housing is a consumers’ good, as much as are one’s
automobile, furniture, or appliances. An essential difference between a capital
good and a consumers’ good is that the purchase of the former serves to bring
in the funds necessary for its maintenance and ultimate replacement, together
with a profit, which profit contributes to one’s ability topurchase consumers’ goods.

Consumers’
goods, in contrast, do not normally bring in funds to make possible their maintenance
and replacement. These funds must come from a source distinct from the
consumers’ good, such as, typically, a job, the ownership of a business, or the
receipt of dividends or interest. They thus represent a using up of funds
rather than being a source of funds. It is this that makes them consumers’ goods.

As I
mentioned earlier, what makes housing seem like a capital good is the
government’s policy of continuous inflation of the money supply. This
systematically raises home prices and allows people to assume that the purchase
of a home will turn out to be a profit-making investment when they ultimately
sell it.

In reality,
even though inflation makes it possible to sell houses for more than one paid
for them, in the long-run the monetary gain is typically insufficient to
compensate for the intervening rise in prices. Thus, for example, imagine that
over a thirty-year period, prices, including the price of new houses, triple. Other
things being equal, the rise in the price of a thirty-year old house must be
substantially less than the rise in the price of a new house, simply because it
is thirty years old and has undergone substantial wear and tear. If its price
has merely doubled, there is a one-third loss in purchasing power.

Of course,
the homeowner can still have an actual gain, if he financed his purchase with a
mortgage. If for example, he borrowed, say, $80,000 of a $100,000 purchase
price back in 1984, in 2014 he could conceivably end up with twice his initial
investment after allowing for the rise in prices. When he sold his house at
twice its purchase price, his equity would be $120,000 even in the face of an
unchanged mortgage debt. After allowing for the tripling of prices, this would
represent the equivalent of $40,000 of purchasing power at the time of purchase.

But in this
case, the homeowner’s gain would be at the expense of much more than an
equivalent loss on the part of the mortgage lender. The mortgage lender, who
began with a buying power of $80,000, now, after a tripling of prices, has a
buying power of only one-third of that amount, i.e., $26,667. This constitutes
a loss of $53,333 in buying power. He has lost not only the $20,000 in buying
power that the homeowner has gained, but over and above that, he suffers the
additional loss of $33,333 that reflects the loss in purchasing power represented
by the house itself. Clearly, purchase of the house entails an overall loss,
or, more correctly, consumption.

Fourth and
finally, classifying owner-occupied housing as a capital good, leads to the
distortion of inventing an income earned on the alleged capital invested in
this good. This is the “rental equivalent” that Piketty mentions. What is
entailed here is imagining that the homeowner rents his home—from himself—at
the going rate for the actual rental of such a home in the market. This
fictional rent is then treated as a kind of sales revenue for the homeowner.
The homeowner’s expenses for maintenance, repairs, utilities, and the like are
treated as costs to be deducted from the make-believe sales revenue. The result
is an alleged net rent or profit. All of these “profits” are then added to the
profits earned by business firms and count in the alleged growing disparity
between profits and wages.

Piketty
could easily enlarge the profit share of national income even more by applying
the same procedure to all durable consumers’ goods for which there are rental
markets, most notably, automobiles, furniture, appliances, even clothing. Then
there would be still more profits relative to wages, and an even worse alleged problem
concerning the height of the capital/income ratio.

It must be
assumed that Piketty’s data for profits is also flawed by the inclusion of
imputed interest payments. This inclusion is a standard practice in
contemporary national income accounting. In this fiction, bank depositors are alleged
to receive as interest income not merely the interest they actually do receive,
but the whole amount of interest earned by the banks on their loans, before any
deductions for the banks’ costs. This, of course, further inflates the amount
of profit thought to exist in the economic system.

I cannot
say what other errors may exist in Piketty’s data. But in any case, data are
not what counts here. Controlled experiments are impossible in economics. Economists
do not have different planets or different countries that they can make
identical in all respects save one, and then observe what further differences
follow. As a result, whatever data that exist are reflections of myriad causes
whose effects cannot be experimentally isolated.

Fortunately,
laboratory experiments are not only impossible in economics, they are also
unnecessary. It is possible to discover comprehensive economic knowledge
through application of the laws of arithmetic and deductive reasoning applied
to such axiomatic knowledge as the fact that people prefer more goods to fewer
goods and thus lower prices to higher prices and higher incomes to lower
incomes.

The
demonstration, earlier in this essay, that when the capitalists reduce their
expenditure for consumers’ goods and use the resulting savings to increase
their expenditure for labor and capital goods, the amount of wages in the economic
system rises and the amount of profit falls, needs to be carried further.[38] For it strikes at the deepest
foundations of the anti-capitalistic mindset that Piketty represents. Namely,
at the belief that profits are a deduction from what is originally, and naturally
and rightfully, all wages and are unearned. It implies nothing less than that
the opposite is true, that profits are the original and primary form of labor
income and are fully earned.

The
connection between the demonstration and that conclusion is a reversal of the
example that I used. Thus, instead of assuming that the capitalists reduce
their expenditure for consumers’ goods and increase their expenditure for labor
and capital goods by 100, assume that they do the exact opposite. They decrease
their expenditure for labor and capital goods by 100 and use the funds to increase
their expenditure for consumers’ goods by 100. In that case, total wage
payments in the economic system fall and profits rise by 100. The rise in
profits occurs because sooner or later aggregate costs of production fall by
100, reflecting the fall of 100 in the expenditure for labor and capital goods,
while aggregate sales revenues in the economic system remain the same. Aggregate
sales revenues remain the same inasmuch as the rise in spending for consumers’
goods by the capitalists offsets both the drop in spending for capital goods
and the drop in spending for consumers’ goods by wage earners resulting from
the fall in wages.

Imagine
that the fall in spending for labor and capital goods and rise in spending for
consumers’ goods by the capitalists goes so far that there is no longer any
spending at all for labor or capital goods, but only spending for consumers’
goods. The capitalists would no longer be capitalists, but they would still be
sellers of products and still have sales revenues. Of course, the goods
produced would be extremely primitive. The absence of spending for labor and
capital goods would mean the virtual absence of division of labor in the
production of a good, because the good would have to be produced both without
the aid of hired labor and without the aid of previously produced products
purchased from others.

Be that as
it may, in a situation in which there are sales revenues and zero spending for
the purpose of bringing in those sales revenues, there will be zero money costs
of production, and thus the entire sales revenues will be profit. At the same
time, with zero spending for capital goods and labor, the money value of
capital invested will fall to zero. The rate of profit will then be infinite,
as a positive amount of profit—profit equivalent to sales revenues–is divided
by a zero value of capital.

However
bizarre such situation may seem, it is nevertheless the starting point for two
of the world’s most famous writers on the subject of economics: Adam Smith and
Karl Marx. Smith describes the situation sometimes as “the early and rude state
of society” and sometimes as “the original state of things.”[39] Marx describes it as “simple
circulation,” i.e., the sale of commodities C, for money M, followed by the use
of the money received for the purchase of other commodities C. His formula for
simple circulation is C-M-C.[40]

The
difference between their description and mine is that they mistakenly believe
that the income that is present when there are sales revenues and zero money
costs of production is somehow wages rather than profits. They believe that it
is wages, because the manual workers who produce whatever can be produced in
such circumstances perform labor and the income of labor is supposed to be
automatically, and without question, wages. The truth, of course, is that the
income of the workers in this situation is not wages, but profit! It is sales revenues from which zero costs are deducted.
Thus, profit, not wages, is the original form of labor income.

Having
mistakenly assumed that the income of the workers is wages, Smith and Marx go
on to conclude that profit comes into existence only later, with the appearance
on the scene of capitalists and their capital, and is then a deduction from
what was originally, and naturally and rightfully, wages. The truth, of course,
is that the capitalists, so far from deducting profits from wages, are
responsible for the existence of wages and expenditures for capital goods,
which then show up as costs of production deducted from sales revenues and
reduce profits equivalently. Profits are not a deduction from anything. Wages
and the other costs are a deduction from sales revenues, which were originally
all profit.

Ironically,
the truth of the matter can be expressed in terms of Marx’s formula for “capitalistic
circulation.” Here, production begins with an outlay of money M, which is used
to purchase labor and capital goods for the purpose of producing commodities C,
which are intended to be sold for a larger sum of money M’. This is expressed
in Marx’s formula for capitalistic circulation, which is M-C-M’.

This
formula can be used to express what I have called “the economic degree of
capitalism,” namely, the ratio of M to M’.[41] Smith’s early and rude state and
Marx’s simple circulation represent a zero economic degree of capitalism, i.e.,
M=0/M’. The more economically capitalistic is the economic system, the higher
is the ratio of M to M’.

The example
I used against Piketty was essentially just showing the effects of a higher
economic degree of capitalism on the relationship between wages and profits. A
rise in M reflects in part a rise in wage payments by business and in part a
rise in expenditure for capital goods. Since M’, which represents aggregate
sales revenues, remains the same in amount, the rise in M results in an
equivalent drop in profits in the economic system as soon as costs of
production rise to equality with the now higher level of M. Within M’, the
portion constituted by expenditures for consumers’ goods falls, while the
portion constituted by expenditures for capital goods rises. Within the portion
constituted by expenditures for consumers’ goods, the portion coming from wage
payments rises, while the portion coming from the capitalists falls. The
overall total of sales revenues is thus unchanged.

The higher
economic degree of capitalism operates in favor of wage earners in a twofold
way. It raises the wage share of national income and, more importantly, in
accordance with the principles of capital accumulation and economic progress
explained earlier, if it is high enough, it can set the stage for a continuing
rise in the productivity of labor, which operates continually to increase the
supply of consumers’ goods relative to the supply of labor and thus continually
to reduce prices relative to wages, thereby progressively raising real wages.

I’ve shown
that in the conditions postulated by Smith and Marx as their starting point,
profits are an income attributable to the performance of labor, and, indeed,
the only income attributable to the performance of labor in those conditions,
because without the existence of capitalists, there are no wages paid in
production, wages being money paid in exchange for the performance of labor,
not for the products of labor.

Now the
question is, are the profits earned by capitalists—by the sellers of products
in the conditions of “capitalistic circulation”—an income attributable to the
performance of labor by the capitalists? Can the profits of big businessmen,
such as Ford and Rockefeller, and Gates and Jobs, be understood as being earned
on a foundation of their performance
of labor, despite the fact that their performance of manual labor is minimal,
limited to such things as jotting down thoughts, dictating memos, and reading
reports.

Remarkably, the essence of the
answer is provided by none other than Adam Smith, about 200 pages after he
presented his mistaken belief that the income of workers producing products in “the
“early and rude state of society” is wages. Here he tells the reader,

It
is the stock [capital] that is employed for the sake of profit, which puts into
motion the greater part of the useful labour of every society. The plans and
projects of the employers of stock regulate and direct all the most important
operations of labour, and profit is the end proposed by all those plans and
projects.[42]

Smith has named the essential
fact that it is the plans and projects of the capitalists, motivated by profit,
that drive the economic system and regulate and direct how its labor is used.
The exercise of that function qualifies capitalists as being workers and
producers. They provide guiding and directing intelligence to the means
required to achieve the goal of producing a product. This is essentially what
every worker does, though most workers do it on a far lower scale.

A manual worker uses his arms
to produce his product. What makes him a producer is not the fact that he uses
his arms, but that his mind directs
the use of his arms to achieve the goal of producing the product. His mind
provides guiding and directing intelligence
to his arms and to whatever tools, implements, or machines he may use in the
production of his product.

Now a capitalist supplies goals
and provides guiding and directing intelligence not merely to his own arms and
whatever tools or implements he may personally use, but to an organization of men, whose material means of production he has
provided. A capitalist is a producer by
means of the organization he controls and directs. What is produced by
means of it, is his product.

Of course, he does not produce
his product alone. His plans and projects may require the labor of hundreds,
thousands, even tens of thousands of other workers in order to be accomplished.
Those workers are appropriately called “the help”—in producing his products. Thus, the products of Standard
Oil are primarily the products of Rockefeller, not of the oil field and
refinery workers, who are his helpers. It is Rockefeller who assembles these
workers and provides their equipment and in determining what kind of equipment,
tells them what to produce and by what means to produce it.

I hasten to point out that the
standard of attribution I have just used, is the standard usually employed, at
least in fields outside of economic activity. Thus history books tell us that
Columbus discovered America and that Napoleon won the battle of Austerlitz.
What is the standard by which such outcomes are attributed to just one man? It
is by the standard of that one man being the party supplying the goal and the
guiding and directing intelligence at the highest level in the achievement of
that goal.

Now I also want to point out
that everything I have said is perfectly consistent with the well-known fact that
in business the amount of profit a firm earns tends to vary with the size of
its capital. Of course it does. A businessman who owns one store or one factory
will earn a certain amount of profit. If he owns ten such stores or factories,
it should not be surprising that he earns ten times the profit. His labor is of
an intellectual nature and thus can be applied the more extensively the larger
is the capital he owns. In ignorance of this fact, Adam Smith assumed that in
order for profits to be attributable to the labor of a capitalist, they would
have to be proportional to his labor, and since they were more likely to be
proportional to his capital, this precluded their being attributable to his
labor.[43]

Smith was clearly mistaken in
reaching that conclusion. Results are always to be attributed to labor, because
labor is what provides the guiding and directing intelligence to the means
employed for achieving them. It is on this basis, that we say that a worker
using a steam shovel digs a hole no less than a worker using a conventional
shovel. Here the result varies dramatically with the means employed, but still
it is always attributable to labor, because labor is what provides the guiding
and directing intelligence. In just the same way, it is the labor of businessmen
and capitalists that provides guiding and directing intelligence to
organizations of men, who, within the framework of an organization provide
further guiding and directing and intelligence. The possession of greater
capital allows a businessman to hire and equip a larger, more potent
organization to carry out his plans and projects. Still, the plans and
projects, and the results, are his. The contribution of everyone else takes
place within the framework that he provides and oversees.[44]

The controversy over economic
inequality and much of the history of the world can be grasped by envisioning
two very different scenes. In Scene One, everyone is equal. Everyone lives in a
mud cabin or equivalent, without electricity or running water. Hunger and
malnutrition, disease and death, are rampant. Famine and plague are ever
present threats. But social “justice” prevails, because everyone is equal.

In Scene Two, practically everyone,
even the very poor, lives in a modern home or apartment, with electricity,
indoor plumbing, a refrigerator, stove, and heating and air conditioning. He
has a television set, a cell phone, a computer, and even an automobile.
Obesity, not hunger, is the problem. But some people are much richer than
others. Their great wealth is invested in the means of production that supply
everyone with all these goods and much more, and serves as the source of wages
and salaries; and, of course, they personally enjoy more and better of all
these goods than the average person.

But Scene Two is incompatible with
“social justice.” It supposedly represents injustice, because it violates some
kind of alleged divine right of everyone to be equal. The existence of economic
inequality is held to be immoral because it is profoundly offensive to many
people, particularly professional intellectuals who grossly overrate their
intellectual powers and abilities. It holds up the mirror of reality and makes
such people glimpse the fact that many of those they consider to be their
intellectual inferiors are actually better than them. This is a fact that they
cannot bear to recognize and that they feel compelled to destroy. So, in the
name of “social justice,” they vilify, rob, and murder the wealthy capitalists
they hate, whose only crime in bringing prosperity to all is to reveal such
people’s enormous overestimation of themselves.

Piketty seeks
deliberately to prevent capital accumulation, through income tax rates as high
as 80 percent. He seeks to destroy capital that has already been accumulated, by
taxing it at rates as high as 10 per cent per year. If enacted, his proposals
would constitute a major addition to the destructive forces already at work in
our country and responsible for our existing state of stagnation and decline.
They would push the economic system into far more dramatic decline. The battle
over economic inequality would be shifted from complaints about others having
more houses and cars toward complaints about others having more potatoes or
rice.

Piketty
urges these destructive policies, at least in part, because he is enormously
ignorant of economic theory. The leading figure among his intellectual sources
is Karl Marx, apparently followed by Robert Solow. Mises and Böhm-Bawerk are
absent, and, when it comes to capital, so too is Ricardo. As a result, Piketty
has no understanding of the role of capital in production and a badly confused
and inadequate understanding of the theory of profit and the theory of saving
and investment.

America and
the world, above all the wage earners of the world, need the abolition of taxes
and regulations that stand in the way of capital accumulation and the increase
in production. Capital accumulation and more production, not egalitarianism and
its absurd theories and programs, are the foundation of rising living standards
in general and rising real wages in particular.

If enacted,
the program Piketty urges would be as devastating in its consequences as his
knowledge of sound economic theory is slight. The popular success of his book
is a measure of the economic ignorance of our time. The endorsements given his
book should be taken as evidence of the economic ignorance of those who gave
them.

[8]
Both dimensions were well understood by the great British classical economist
David Ricardo. In his Principles of
Political Economy and Taxation, in the chapter “Value and Riches,” Ricardo
wrote, “Capital is that part of the
wealth of a country which is employed with a view to future
production, and may be increased in the same manner as wealth. Anadditional
capital will be equally
efficacious in the production of
future wealth, whether it be obtained from improvements in skill and machinery, or from using more revenue reproductively….”
By “using more revenue reproductively,” Ricardo, of course, meant saving and
investing.

[10] The ideas presented in the last ten or so paragraphs are
developed more completely in the author’s Capitalism: A
Treatise on Economics (Ottawa, Illinois: Jameson Books,
1996), pp. 622-642. Hereafter this book will be cited as Reisman, Capitalism.

[24] Productive expenditures constituting selling, general, or administrative
expenses are not additions to the capital assets of firms. They are costs to be
deducted from sales revenues immediately. When subtracted from productive
expenditure, they net to zero.

[25] I must point out here that productive expenditure, not consumption
expenditure, is the main form of spending in the economic system and that it is
made possible by saving out of sales revenue. Productive expenditure is present
without diminution even when net investment and net saving are zero, indeed,
even when they are negative. The role of productive expenditure is obscured by
the fact that it appears in connection with net investment, which, of course,
is the difference between it and the costs deducted from it. The concept of
productive expenditure does not appear in contemporary economics, which claims
that consumption expenditure is the main form of spending and that to
acknowledge the existence of productive expenditure is an error, the alleged
error of “double counting.”

[26] Inasmuch as the rate of profit on capital equals the amount of
profit divided by the amount of capital, and the amount of profit equals the
sum of net consumption plus net investment, the rate of profit can be expressed
as the sum of the rates of net consumption and net investment, i.e., the sum of
the amount of net consumption divided by the amount of capital plus the amount
of net investment divided by the amount of capital.

[27] See above, the last four paragraphs of the discussion
in the text under the heading “Time Preference versus Piketty’s Alleged
Limitless Rise in the Capital/Income Ratio.”

[28]
This discussion shows that falling prices caused by increased production can
exist alongside of the rate of profit being positively elevated by virtue of an
increasing quantity of money and volume of spending. It is clearly illegitimate
to describe such falling prices as “deflation.” On this subject, see Reisman, Capitalism, pp. 573-580.

[38] See above, the discussion in the text under the heading “Contrary
to Piketty, Capitalism Progressively Raises Real Wages and Increases the Wage
Share of National Income While Reducing the Profit Share.”